Those who bought shares in GLD, SLV, as well as interests in other inflation hedge investments, have been confused by recent reports which predict so-called “deflation”. Some claim that the world is “deleveraging” and this will cause the dollar to rise in relation to other currencies, and the price of virtually everything else to drop. Many of these pundits point to an alleged “drop” in the M3 money supply, in August, to support such allegations.
In these prognostications, however, they ignore the $750 billion dollar per year U.S. current account deficit, and a combination of public and private foreign debt which now amounts to over $9 trillion U.S. dollars. Both the current account deficit and the overall foreign debt will rise now that the dollar has been increased in value in relation to other currencies. The reduction in the nation’s oil bill is a relatively small part of the current account deficit, and cannot make up the difference, as ever more financially strapped Americans buy more and more from deep discounters, like Wal-Mart (WMT) and Costco (COST), who stock their stores with cheap foreign imports. Indeed, these two were about the only retailers to see increased August sales.
For those who believe the money supply is falling, let me show you a chart, which tracks the M3 money supply. The thick blue line is the increase in money supply in percentage terms, whereas the thinner, black line is the absolute amount of M3. As you can see, M3 has remained steady at about $13.3 billion. The only thing that turned down, in August 2008, was the percentage increase. Contrary to deflation theory, the money supply is NOT falling.
The downward adjustment of the rate of increase is probably the result of a coordinated dollar intervention, by central banks, which has been ongoing between late July, 2008 to early September, 2008. In spite of the blip, however, the long term chart shows that U.S. dollar money supply (even before considering credit derivatives) has grown well in excess of losses from the so-called “credit crisis”. These losses will total $1 trillion, according to the IMF, but I estimate them to be closer to $2 trillion. As I will soon explain, the value of work, represented by this lost money, has been gone permanently, and cannot be replaced.
The combination of the M3 money supply, plus all credit (including bank, consumer, commercial, and estimated real estate loans) is known as “total money”, and it is probably the most accurate way to view whether or not economic policy is inflationary or not. It is the measure of the total amount of money floating about in the economy, after fractional banking expands the basic inputs of M3. Total money has increased by what can only be described as an explosive force. Since the beginning of August, 2007, it has leapt from about $35 trillion to reach about $43 trillion dollars by the end of August, 2008, an increase of about 23% in one year. Here’s the chart:
It bears noting that M3 must now be obtained from independent economists, like John Williams of www.shadowstats.com, and www.nowandfutures.com, because the Federal Reserve has chosen to stop publishing it. The Fed claims that it is to expensive to calculate M3, and the effort does not justify the “utility.” However, the underlying data continues to be collected and published. All they would need to do is run a spreadsheet calculation on small personal computer. Total cost = very close to $0.00, not including the incremental cost of whatever paper might be used to print it out in physical form.
Is this huge expense too much for the Federal Reserve? Or, is there another reason they don’t want to publish the numbers anymore? Is the refusal to publish M3 yet another aspect of the Orwellian double-speak world that the powers in Washington DC and on Wall Street want to impose upon us? The Federal Reserve obviously wants to hide how much liquidity they are flooding into the market. One thing is sure. The explosion of total money will result in an explosion of inflation. It must. The relationship is mathematical. Double-speak cannot change the laws of physics.
As discussed in my prior article, The Great Dollar Pump of 2008: A Doomed Central Bank Intervention, the U.S. government sold 6 billion euros from the emergency exchange rate stabilization fund [ESF]. The proceeds from this sale must have been used to buy approximately $1 trillion worth of derivatives. Essentially, the $6 billion will be used to “pay interest” on this huge derivative position, so as to take dollars temporarily out of those that are circulating. This has temporarily pumped the value of the dollar, and reduced the value of commodities because they are denominated in dollars.
The ECB and the Bank of Japan, no doubt, have contributed to this effort, and, in all, several trillion dollars were probably taken out of circulation. The hope is that a few months of upward momentum will alter public perception and break the back of anti-dollar, pro-gold, pro-everything-but-the dollar, sentiment. The idea is to have a steady but slow dollar devaluation, not the kind of rout that was taking place in early July, 2008.
Henry Paulson, no doubt, planned carefully for the socialization of Fannie (FNM) and Freddie (FRE), months ago. The event was well organized, and he was clearly not caught off-guard by a finding by the Morgan Stanley team that the two GSEs were misstating their capital reserves.
Dollar intervention has been carefully timed to neutralize the socialization event, first by pumping up the dollar beforehand, and, later, by countering the hordes of people who were selling the dollar in the morning of September 7, 2008. That is why we saw the dollar collapse, temporarily, in the early morning trading, on Monday, and, then, subsequently, rebound to a strong positive showing, as New York currency trading got under way. Without this intervention, the dollar index would have collapsed to about 60 by Monday, September 7, 2008, and negative feelings about the dollar would have become so entrenched that no amount of intervention might have been able to offset it.
The dollar manipulation has been painful to many innocent investors, but it has managed, yet again, to put off the day of reckoning. The temporary refusal of trends will allow favored institutions, and friends of those in power, to exit dollar and other paper money denominated assets, and buy hard assets at a cheap price. In 2005, another temporary intervention propped up the dollar and slowed its long term decline. The effect lasted less than a year. But, back then, the credit crisis was not yet perceived by market players.
Now, people are well aware of the irresponsible actions of our government in concert with Wall Street. The effect of the latest dollar manipulation, therefore, will be much shorter. Active intervention must end very soon, because, if central banks continue to restrain the U.S. dollar money supply, much past the end of August/beginning of September, they will tip the balance, and throw the world into a new Great Depression. Bernanke’s writings make it clear that they are keenly aware of that.
It is important to understand certain basic economic principles before we can understand what is happening. We must first abandon abstraction, and look carefully at each thing, so that we can see it for what it really is. By tossing the jargon and the code words, we will be able to tune into reality, past the loud din of market chatter.
First of all, the strength of all economies are based upon the amount and efficiency of the productive work done. That is the key to economics. “Work” is any productive activity by individuals or groups of people, who perform useful tasks that benefit society in some way. “Money” is the credit people get for that work. It is a form of “stored work”. It can be used to compel other work, from other people, in the future, to pay you back for the work you did, in the past. The work I do today will provide credits with which I can buy someone else’s work, tomorrow.
Anything that serves as a storage medium for work value is money. Historically, the most common money has been gold and silver. In some societies, however, money took the form of pearls, or even seashells. In modern times, money has mostly consisted of little slips of paper which we call “currency”. The slips of paper derive their value from the ability of the governments that issue them to compel work in exchange for the paper. This is the concept of backing paper money with the promise of the “full faith and credit” of the government.
The value of paper money is dependent on whether or not people trust that the government can compel people to do work in the future, in exchange for the particular pieces of paper that the particular government chooses to print. Paper money is, therefore, called “fiat” money because its value arises out of the fiat power of the government. The government says it has value, and, therefore, it does. The value of things like seashells, pearls, gold and silver, in contrast, is derived not from government fiat, but, rather, from the desire of people to possess rare or beautiful items.
“Debt” is created when someone with more stored work-value (money) than he needs, lends it to someone who has less than he needs. In exchange, the person with less money pledges to pay back the loan with his future work. Future work is eventually converted into stored work (money), and is paid back to the lender. Borrowers take loans from lenders because they want to obtain something of value to them. The thing of value, however, does not have equal value to all people. It will almost always be much more valuable to the borrower than to the lender.
Take a house, for example. The bank can’t live in a house, so its value is far higher to the borrower than to the bank. That’s essentially why banks lose money when they foreclose on houses. Banks must do work to get rid of the borrower, and, then, later, to find someone else for whom the house has value. Since work is money, banks lose money on foreclosures.
Now, because so many people bought houses with a promise to pay back more work than they can really do, the banks are forced to lose stored work (money) by taking back a lot of houses. New borrowers, having seen what happened to the first borrower, don’t want to promise more work than they can really do. So, they tend to make lower offers. In addition, because so many houses are becoming available at the same time, each one has become less rare and, therefore, less valuable to a potential new buyer.
In short, when a borrower takes more debt than he can afford, it really means that the borrower’s future work is not valuable enough to pay off what has been lent to him. Conversely, when a lender gives money to a borrower, and the borrower defaults, it means that the lender will lose the value of some of stored work (money) it has lent out.
That is what is happening now, in the so-called “credit crisis.” Banks made a lot of stupid loans, and borrowers cannot afford to pay them back. A lot of fraud occurred at the same time, with Wall Street telling everyone that the borrowers were more capable people than they really are. Investors paid for mortgage-backed bonds with stored work (money).
But, huge inefficiencies in work allocation have occurred. Fools and corrupt people, running the financial system, have transferred trillions of dollars worth of previously stored work, to people whose labor is of insufficient value to return it. In the process, bankers were busy skimming money (stored work), in the form of outsized salaries, bonuses and stock options. In short, the stored work of society, which came from a host of hard working honest decent people, was consumed by a combination of manipulative high living Wall Street executives who frittered it away on extravagant living, and average Joe’s who just aren’t willing or able to generate the quality or quantity of work needed to pay their debts.
The government can try to replace the physical units of work storage by printing new money. But, printing units of storage (dollars) doesn’t replace the lost work. New money can be used to store new work, but if the government prints it fast, as it has been doing, a big increase in the money supply means that the remaining amount of previously stored work will be worth that much less. Excess money supply growth means that each unit of work will be represented by a larger number of money units. Thus, each unit of money will be worth less. This creates inflation, because less work is chasing after the same amount of goods and services.
A lot of society’s work effort, over a term of years, has been lost through corruption and economic inefficiency. It will never return. You cannot replace it simply by printing money, which are simply storage units and not work itself. Instead, in order for the economy to recover, society must accept the losses, prosecute the guilty, and start working harder to create full, rather than inflated, new units of stored value.
The only way to motivate people to recover from a downturn like the one we are now in, is to be honest with them, which is the opposite of the tactics that are being taken by Congress and the Bush Administration. Ben Bernanke, the FMOC, Hank Paulson, and the U.S. Treasury have not taken the honest route. Instead, they have decided to print more money, in the hope that the complexity of the economy will confuse the majority of people. The hope is that by manipulation of the value of the dollar, in relation to other paper money, with the help of other central banks around the world, everyone will be so confused that they will, somehow, not realize that a lot of value has now been stolen from the system, and will never be returned.
Let’s take a look at a chart showing the link between the money supply and inflation from as early as 1910 to the present. As the money supply increases, real inflation increases with it. Real inflation is represented by the dark black line, which is the true consumer price index, reported by John Williams of www.shadowstats.com, after removal of the hedonic and geometric lies that the government now inserts into the numbers. John Williams recalculates CPI, using the government’s pre-1982 formula. This harmonizes all the numbers, and corrects the current government numbers, back to a time before it began lying about inflation. The relationship between higher money supply and higher inflation will never change, regardless of falsifying the numbers to make it seem that way.
The U.S. Treasury is now pledging to print $200 billion dollars to bail out Freddie Mac and Fannie Mae. This alone will increase the money supply exponentially, when it is multiplied through the miracle of fractional banking. William Poole, former President of one of the regional Federal Reserve Banks, who was critical of Freddie & Fannie for many years, and resoundingly ignored, says that it will cost a minimum of $300 billion to bail them out.
That calculation is conservative. I estimate that the total loss will be closer to $600 billion, or 10%. Independent analyst, Chris Whalen, at Institutional Risk Analytics, estimates that the FDIC will eventually pay out $500 billion in replacing deposits lost at hundreds of failing banks.
The Federal Reserve has converted some $450 billion worth of highly default prone mortgage paper into cash by compromising and polluting its own balance sheet. Congress has given away $150 billion in a so-called “stimulus plan” for its constituents, and Barney Frank and other Democrats are pushing for another cash giveaway. When all these giveaways are multiplied by the fractional nature of our banking system, the M3 money supply increases exponentially. And, the process is continuing.
Ben Bernanke fancies himself a student of the Great Depression of the 1930s. He has spent most of his academic life studying it, writing papers about it, and talking about it. In a 2002 speech, given on the 90th birthday of famous economist, Milton Friedman, for example, Bernanke stated:
Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve System. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.
He continued that speech by quoting from a statement by Milton Friedman, made many years before. Friedman has stated that it is theoretically impossible to have deflation in a fiat money based economy. So long as the government has a printing press, and enough helicopters, free money can be dropped from the sky and that would prevent deflation. Bernanke would eventually live to regret repeating that statement because it gave him his pet name, “Helicopter Ben”, and this name has stuck to him, like glue, ever since.
The last time America saw real deflation, was at the time of the Great Depression. In the old days, of course, we were not supposed to have had a fiat money system. Supposedly, the value of the dollar was based upon the value of gold. People said, in those days that “the dollar is good as gold”, because the government was legally liable to trade each dollar, for the sum of 1/20th of an ounce of pure gold.
But, the gold standard was a lie. The dollar was never really tied to gold. This big lie would come back to haunt us, as the cause of the Great Depression. Lying, stealing and speaking falsely causes lack of confidence in the system, and confidence, or lack thereof, is the ultimate cause of booms, busts, recessions and depressions.
In spite of the alleged gold standard, during the 1920s, the government printing press began to go wild. They started printing far more paper dollars than could be redeemed in gold. As you can see, in the charts above, inflation resulted. The price of houses and stocks boomed. But, the out-of-control inflation that we fear today didn’t start until 1933. In 1933, each U.S. dollar was still worth 40 of today’s dollars, because that is approximately what 1/20th of an ounce of gold costs today. Since 1933, however, when President Franklin Roosevelt ended the convertibility of U.S. dollars to gold, and forcibly confiscated private gold held by U.S. citizens, the dollar has depreciated by 40 times, and inflation has increased by a similar amount.
Debt levels in the 1920s were helped along by the U.S. Treasury and Federal Reserve, who expanded the U.S. money supply at the surging of Wall Street interests who wanted the stock market to surge, much like today. Eventually, the party ended, however, as it always does. The Federal Reserve had been created in 1913 to prevent panics. Yet, on October 29, 1929, now known as “Black Tuesday”, the worst panic in history happened. The stock market crashed back down to earth.
It didn’t all happen on one day, of course. The stock market made a huge temporary recovery, and people actually spent more money in the first half of 1930, than they had in the first half of 1929. But, by the second half of 1930, things began deteriorating again. Consumers tried to keep up their payments on debts accumulated in the 1920s, and they stopped spending. To make matters worse, a severe drought took hold in the agricultural heartland, now known as the “dustbowl days”. It took fully 3 years of deterioration, from 1929 to 1933, for the Great Depression to gain its stranglehold on America.
Many people, including Ben Bernanke, have speculated as to what caused the Great Depression. Nobody knows the answer. Our Fed Chairman believes that the U.S. money supply was not “elastic enough.” He thinks the crash was caused by debt-deflation and constraints, imposed partly by the gold standard, on the ability to expand the M2 money supply. He believes that reliance on cheap credit in the 1920s fueled short term growth, but that huge numbers of businesses and people were thrown into default when the money supply contracted and price deflation happened.
In fact, consumers and businesses drastically cut spending to keep up debt payments, and this reduced demand for new goods. Manufacturers stopped hiring workers and fired them instead. Unemployment grew until it reached 25%. Depositors worried about the safety of their bank deposits, and began withdrawing money en masse. There was a generalized bank run, and banks began to collapse. A huge number of people tried to convert their dollars to gold, but, because the Federal Reserve had allowed the money supply to grow far in excess of what could be redeemed, back in the 1920s, it was forced to allow the money supply to shrink by 1/3 between 1930 and 1933, as people redeemed their paper dollars for gold.
Bernanke believes that if sufficient “liquidity” had been supplied, in the form of emergency lending to key banks, bond buying on the open market, and so on, the depression might have been averted. Aside from being tight friends with many executives at the big banks, that is why the FMOC has sent a flood of cash from taxpayer’s pockets to the coffers of America’s big banks.
Deflation is impossible under a Bernanke-led Federal Reserve. Things are very different now than they were back in the 1930s. Money expanding policies are in full swing. Depositors are not worried about losing their money in banks. Even as I write this, many are taking CDs at what they see as “good” rates, from banks close to failure, like Washington Mutual (WM), Wachovia (WB), Key Bank (KEY) and others.
Depositors believe in the FDIC insurance fund. People are not converting dollars to gold. They can’t. The government admits its dollars are backed by nothing but empty promises. We make no pretense to being on a gold standard. When a bank goes under, the dollars on deposit are immediately replaced. Replacement dollars will be printed if needed. The new dollars will look exactly the same on electronic spreadsheets, though they will now be worth far less, because the stored work that backed the ones that have been lost, has been frittered away. With each new dollar printed, the dollar loses rareness. There will be more dollars chasing after the same amount of goods, and services. That is the essence of inflation, not deflation.
Contrary to popular fancy of those who say the U.S. government is rock-solid, the United States of America went bankrupt in 1933. It didn’t walk into a courtroom, and ask a judge for mercy, like individuals do, when they file bankruptcy. But, it declared bankruptcy nonetheless. It defaulted on its most basic promise to the American people and the world. It failed to make good on its legal obligation to convert dollars to gold.
Instead, in 1933, President Roosevelt outlawed private ownership of gold, and forcibly confiscated all gold held by private citizens. This was the ultimate treachery of a deadbeat debtor. It was the act of a totalitarian dictatorship, not a democracy. But, by the time it happened, the government was bankrupt. It could not convert dollars to gold. There just wasn’t enough gold. The entire “gold standard” was all a big lie. By 1934, the dollar had depreciated by government fiat, by 75% in relation to gold. Because our dollars are no longer backed by any gold at all, they will now depreciate by much more, as the money supply keeps rising.
When it became clear that the gold standard was a big lie, confidence was destroyed. That is what caused the Great Depression. Ben Bernanke simply doesn’t get it. Instead, he’s got it backwards. Economic downturn is not created by mathematical fluctuations in money supply. Economic booms and busts are a function of human emotion. When people were lied to, repeatedly, and they see their stored work, in the form of money (which was gold) stolen from them, they lost faith in the government, and in the economy. They became depressed, and rightfully so.
The Wall Street bankers, who siphoned off money in the 1920s, and urged the Treasury to print more dollars than could be redeemed for the promised gold, caused the Great Depression. This same type of greed filled person is also the cause of our current problem. Wall Street bankers, such as Henry Paulson, should have no place within the halls of government.
Distrust toward society, government and banks, and, yes, even bank’s distrust of one another, arises from lack of confidence which, in turn, arises out of repeated lies. If the money supply, back in the 1920s, had been composed purely of gold dollar coins, in different denominations, each dollar being equal to 1/20th of an ounce of gold, as promised, we would never have had a Great Depression. Instead, we would have seen a mild recession, with people pulling back for a while. People would have hoarded their little golden coins, for a while, and, then, after feeling a bit better about things, they would have started spending them again.
The government no longer maintains a pretense that each dollar is equal to gold. That makes it very easy to pump up the money supply. The powers that be, in our modern world, think the same as their counterparts thought, back in the 1920s. They think that by lying to us, they can change the course of economic history. It is not true. Lies breed resentment and fear, and, no matter how carefully the lies are concealed, eventually people learn the truth.
Bailouts for billionaires and socialism for the rich are not policies that inspire confidence. Instead of feeding capital to productive business, the new dollars of our exploding money supply are supporting incompetence. Inefficient use of capital does not save an economy from collapse. Flooding an economy with money, when there is no sentiment to use it productively, simply reduces the value of the units of money, creates irrational demand, and induces massive inflation.
The best longer term investments in this environment will function as a hedge against inflation, so long as they are not subject to the inefficiencies that are being inserted into economy. Therefore, the stock market is a bad bet.
Gold, agricultural land and food products are good bets. Food products are usually perishable, however, and highly volatile. In ancient times, gold was the most stable of all things. But, now precious metals are highly volatile, in the short and even medium term, because of repeated government interventions and staged manipulations on the futures markets. This volatility will be minimal, however, over a longer term of 3-6 years, and the price should rise sharply.
Agricultural land is less manipulated, and less volatile, and repeatedly produces harvests without regard to temporary price increases or decreases of perishable commodities. But, land is already very expensive in most countries in which political risk is low.
